Do Now Write Down Your Answers

Do Now – Write Down Your Answers • Are there some products that you would continue to buy, even if the price were to skyrocket? • Are there other products that you would cut back on, or stop buying altogether, if there was a slight increase in price? • How much of an increase is too much?

Elasticity of Demand What factors effect elasticity of demand?

Elasticity of Demand • Elasticity of Demand is a measure of how consumers respond to price changes – Measures how drastically buyers will cut back or increase their demand for a good when the price rises or falls

Elastic/Inelastic • If you buy the same amount or just a little bit less of a good after a large price increase, your demand is Inelastic (price changes don’t matter) • If you buy much less of a good after a small price increase, your demand is Elastic (very responsive to price changes)

Factors that Affect Elasticity 1. Availability of Substitutes - If there are few substitutes for a good, then even when its price rises greatly, you might still buy it – you believe there are no good alternatives: your demand is inelastic

Factors that Affect Elasticity 2. Relative Importance - How much of your budget do you spend on the good? The higher the jump in price, the more you will have to adjust your purchases

Factors that Affect Elasticity 3. Necessities v. Luxuries - a necessity is a good people will always buy, even when the price increases (demand is inelastic) ex: milk - a luxury can easily be given up (demand is elastic) ex: steak

Factors that Affect Elasticity 4. Change over Time - Consumers often need time to change their spending habits, because it takes time to find substitutes ex: gas

Elasticity and Revenue • Total Revenue is the amount of money the company receives by selling its goods – Determined by 2 factors: • Price of goods • Quantity of goods sold

Total Revenue & Elastic Demand • When a good has an elastic demand, raising the price of each good sold by 20% can decrease the quantity sold by enough to reduce the firm’s total revenue (setting prices too high/low can hurt $$) Price of a Slice of Pizza Quantity Demanded (per day) Total Revenue $1. 00 300 $300. 00 $2. 00 250 $500. 00 $3. 00 200 $600. 00 $4. 00 150 $600. 00 $5. 00 100 $500. 00 $6. 00 50 $300. 00

Total Revenue & Inelastic Demand • When demand is inelastic, price and total revenue move in the same direction – An increase in price raises total revenue – A decrease in price reduces total revenue

Elasticity and Revenue ELASTIC DEMAND As the price is lowered… Total revenue rises As the Total price is raised… revenue falls INELASTIC DEMAND As the price is lowered Total revenue falls As the price is raised. . Total revenue rises

Sum it up Effect of a Price Change on Quantity Demanded INELASTIC DEMAND • Not sensitive to price change • Substitutes not available • Less of income spent on good • Seen as necessity • No time to react in the short term • Very sensitive to price change • Substitutes available • More of income spent on good • Seen as luxury • Substitutes can be found in the long term